Analyse an illustrative performance-based fee schedule and interpret its outcomes

Work through the schedule period by period. Take a base fee of 0.4% plus 20% of return above the benchmark, with a high-water mark on cumulative excess return. Outperform by 3% in year 1: the fee is 0.4% + 0.6% = 1.0%. Underperform by 2% in year 2: the fee is 0.4%, and the 2% shortfall must be recovered. Outperform by 3% in year 3: only the 1% above the mark earns the bonus, so the fee is 0.6%. Against a flat 0.8% fee, the break-even excess return is (0.8% − 0.4%) ÷ 20% = 2%. The client pays more than the flat fee only in years when excess return above the mark tops 2%, but the asymmetric payoff can encourage risk-taking, so check caps, hurdles and the measurement period.